The Facts About a US Recovery and GDP

By: Gerard Jackson | Mon, Sep 7, 2009
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I like reading Larry Kudlow's columns even though I do not always agree with him. In a recent column he wrote that "free-market economies are resilient and self-correcting" and the "Friedmanite monetary stimulus -- which has been substantial -- is gradually exerting a powerful impact on economic growth". (Hey Conservatives, We're Recovering, National Review Online, 1 September 2009). Kudlow is making a serious error. Markets are only "self-correcting" when they are left alone. The tragedy of the 1930s provides more proof than one needs of the truth of this statement.

Kudlow said that "4 percent growth is a lot lower than the 7 to 8 percent growth one would expect after a deep recession". But this kind of increased output is not growth. We have hardcore Dems like Charles W. McMillion, a former contributing editor of the Harvard Business Review, pushing the same fallacy by arguing that Roosevelt's disastrous policies were actually a roaring success because GDP took off under his presidency. Naturally, this committed Keynesian is 100 per cent behind Obama's economic spend and tax policies.

What this Harvard man (the more Harvard graduates I encounter the less respect I have for that university) has failed to grasp is that economic growth is not a reduction in idle capacity: it is the accumulation of capital. Maurice Fitzgerald Scott points out "that all growth must result from investment". (A New View of Economic Growth, Clarendon Press, 1998, p. 15). This led him to the very Austrian conclusion that there is no residual or separate factor called "technical progress" because technical advances are embodied in capital. (Incidentally, Fitzgerald Scott is a Cambridge man, England, and is certainly no Austrian). It follows that a genuine economic recovery must also lead to increased capital accumulation. That does not seem to be the case at present.

Instead of promoting growth Roosevelt's policies encouraged capital consumption. (Hoover was every bit as bad). In other words, the production structure actually shrank even though GDP rose. Professor Higgs calculated that from 1930 to 1940 net private investment was minus $3.1 billion. (Robert Higgs, Depression, War, and Cold War, The Independent Institute, 2006, p. 7). W. Arthur Lewis calculated that from 1929 to 38 net capital formation plunged by minus 15.2 per cent (W. Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205). Benjamin M. Anderson estimated that in 1939 there was more than 50 per cent slack in the economy. (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, pp. 479-48). This is what some contemporaries had to say about Roosevelt's economic policies:

...the present Administration has shown but scant inclination to profit in any way from the errors of its predecessors. By consuming more than we have produced we have succeeded only in digging our way deeper into depression; we have tried to recover from depression by spending our way out of it rather than adopting the alternative procedure, -- the one which has effected recovery from every past depression, -- of saving our way out of it. By the policy of maintaining consumer purchasing power we have had to draw upon our store of past savings, and by so doing we have not only failed to keep up our accustomed rate of capital formation but have actually destroyed past accumulations by neglecting to provide for maintenance, depreciation, and obsolescence. C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, pp. 165-166).

This was not a simple matter of opinion but a factual statement. It should be obvious -- particularly to an economist let alone a layman -- that if a process of capital consumption is underway then we should expect to see a rise in the average age of plant and equipment. The following table reveals that this is exactly what happened during the 1930s.

Percentage of Metal Working
Equipment over 10 Years Old
Year Percent
1925 44
1930 48
1935 65
1940 70
Source: Benjamin M. Anderson's Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, p. 479.

It needs to be pointed out that from 1933 to 1940 M1 increased by nearly 100 per cent, bank deposits by about 116 per cent and the monetary base by more than 100 per cent. You cannot get more Friedmanite than that and yet the country remained mired in depression while capital was consumed. Now monetary expansion works by releasing what the late Professor Hutt termed "withheld capacity". Now when -- as happened during the 1930s -- a government enforced wage rate policy prevents the employment of idle capital and labour then a loose monetary policy is supposed to work by raising the value of the worker's product relative to his wage rate. In simple English, inflation is used to lower real wages rates and so price labour back into employment. The policy failed because Roosevelt and his advisors adhered to the purchasing power of wages fallacy. (This tells us much about the Roosevelt administration's economic incompetence and concradictions).

It's true that Obama is no Roosevelt -- thank God -- and that he has not been able to impose the sort of regulatory regime that locked the US economy into depression in the 1930s. Nevertheless he is still doing a great deal of harm. For example, his intention to double the capital gains tax will strike a severe body blow at capital accumulation and technical progress. (Few understand that capital gains taxes reduce the funding of new inventions and retard investment in research and development projects).

There is also an impending avalanche of new taxes that Obama and his supporters assure Americans will have no affect on growth and living standards. Moreover, his massive deficits and borrowing policies will further retard the process of capital accumulation. It is preposterous for anyone to assert that the combined effect of these policies will not damage the prospects for future economic growth. Such a denial defies both history and sound economics. (How could anyone ever forget the spectacle of Democratic Congressman Pete Stark seriously asserting that the more debt the government accumulates the wealthier Americans will become). In fact, one needs to consider the possibility that the US might now be facing the spectre of capital consumption. It has happened to others and there is no fundamental reason why it cannot once again happen to the US.

There is nothing unique about the Obama's of this world. They come and they go. But you can guarantee one thing: their presence eventually turns into a misfortune for others. In the 1920s Austria's Social Democrats implemented their version of Obama's vision. Theirs was a world in which every worker got a square deal and his union stood ready to defend him against rapacious capitalists, a world in which capitalist inequalities were verboten and the social good prevailed over profit motive and greed. And how did that turn out? It was calculated that from 1918 to 1930 Austria lost something like 79 per cent to 87 per cent of its capital. Fritz Machlup to caustically observed that

Austria was successful in pushing through policies which are popular all over the world. Austria has most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits, she increased consumption. After all those achievements she was on the verge of ruin. (Fritz Machlup, The Consumption of Capital in Austria, Review of Economic Statistics, II, 1935, p. 19).

I have said more than once that history never repeats itself: what happens is that people keep forgetting it.



Author: Gerard Jackson

Gerard Jackson

Gerard Jackson is Brookes economics editor.

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